insight magazine

The CPA’s Intro to Hemp and CBD Accounting

To serve one of the fastest growing industries in the country, CPAs must understand how accounting for hemp and hemp-derived CBD is different—and why it’s a great growth opportunity. By ANDREW HUNZICKER, CPA | Winter 2019

Cannabis-800

Cannabis, CBD, hemp, marijuana, THC. You’ve surely heard all these terms by now, but in order to fully grasp and understand accounting for the fast-growing hemp and hemp-derived CBD industries, you need to know the different characteristics of the Cannabis plant and the laws governing its growth and distribution.

Wrap your head around this: hemp and marijuana are both derived from the Cannabis sativa L. plant. So, while both are technically cannabis, the first major difference between hemp and marijuana that you should note is that non-drug hemp or industrial hemp was federally legalized under the 2018 Farm Bill while marijuana remains a federally illegal drug under the Controlled Substances Act. Why is that?

First, industrial hemp is bred to have a low concentration of THC (0.3 percent or less, per section 10113 of the 2018 Farm Bill), or tetrahydrocannabinol, which is responsible for the psychoactive effects of cannabis when used as a drug (which may have THC levels exceeding 30 percent). Second, industrial-use hemp has a high concentration of cannabidiol (CBD), which decreases or eliminates THC’s psychoactive effects. In short, legal hemp can’t get you high and its industrial and commercial uses reach far and wide—think paper, textiles, fuels, edibles, oils, pain relievers, and more. In fact, archaeologists suspect hemp was the earliest plant cultivated for textile fiber and the oldest example of human industry. Fun fact: Hemp cord was found in an ancient village dating back more than 10,000 years in a region we now recognize as Taiwan.

Today, hemp and hemp-derived CBD are experiencing a renaissance. But what does this mean for you? New business opportunities. With hemp and hemp-derived CBD federally legalized, they are no longer subject to the provisions of Internal Revenue Code 280E. This means companies engaged in the hemp and hemp-derived CBD verticals can now take normal deductions just like other businesses. This is a game-changer for many existing businesses and opens a vast market for new businesses to enter.

GROWING YOUR PRACTICE

Currently, there are more than 500 hemp cultivation licenses issued in Illinois and more are on the way as the industry grows and Illinois farmers seek a means for diversifying away from the state’s two primary crops of corn and soybeans.

In order to grow or process hemp in Illinois, a company must be licensed by the state and pay fees. All hemp grown in Illinois is subject to lab testing to ensure its compliance with state and federal laws. For example, the Illinois Department of Agriculture mandates hemp with THC levels greater than 0.7 percent must be destroyed, which has huge business implications.

I often ask my new farmer clients what it costs to grow a pound of hemp. If I can even get an answer, I then ask how they do cost accounting. That is when I usually get a blank stare or silence, because 99 percent of hemp growers and hemp-derived CBD producers simply have no idea how to do this type of accounting.

This is just one example of the many areas within the legal hemp and hemp-derived CBD verticals that you can specialize in—think farming and cultivation, transportation, processing (like turning the plant in to CBD oil), manufacturing (like turning the hemp fiber in textiles), retail, and more. If you can master a niche and become a “VIP” (Valuable Expert, Instructor, and Participant) in that realm, good things will happen for your practice.

I have found that attending local or regional industry events is the fastest way to get immersed in this evolving space and identify service areas to address. Despite the stigma associated with the entire cannabis industry, what I can tell you from firsthand experience is that serving the federally legal hemp and hemp-derived CBD verticals carries less risk than serving medicinal or recreational marijuana clients. What I can also tell you is that the hemp and hemp-derived CBD markets are growing in Illinois and the businesses operating in these spaces, along with the much broader cannabis industry, are vastly underserved by CPAs due to the nuances and complexities—and perceived risks—that come with serving them.

The primary struggles of hemp and hemp-derived CBD businesses revolve around deciphering complex tax codes, such as 471, 263A, 199A; not practicing or understanding cost accounting or farm accounting; implementing GAAP; poor inventory policies, procedures, and controls; no inventory counts or reconciliations; new industry software; and navigating multi-entity issues and industry consolidations. Something worth noting if you’re interested in serving the broader cannabis industry is that many of the tools, workpapers, and charts of accounts used to serve the federally legal hemp and hemp-derived CBD markets transition over to state legalized medicinal and recreational marijuana markets.

All things considered, there are services far beyond accounting, audit, and tax that you can deliver to clients in these spaces. Think CFO services to start, which could include the areas of HR and compliance. In fact, compliance is often a significant pain point for CEOs that costs their businesses thousands of dollars in fees and penalties and sometimes even leads to license revocations or jail time. These are all areas where you can establish your “VIP” status and build a successful practice.

MORE TO CONSIDER

When it comes to federal taxation, you must truly understand IRC 471, IRC 263A, Sec. 199A, and farm accounting. Hemp growing is defined as farming, meaning Schedule F can be used when filing Form 1040. The IRS’ 90-page Farmer’s Tax Guide should be read closely. You must also be able to determine whether cash or accrual accounting is best for your client. In the most general sense, the benefit of cash accounting is that it usually defers taxes, but I would argue accrual accounting gives a more realistic picture of the business and is better for cannabis-related businesses and their needs for raising capital, determining valuation, complying with audits, and strengthening their management reporting.

When you add in state and local tax and compliance matters, the challenges hemp and hemp-derived CBD businesses face become more complex. In my experience, there are no answers that apply to all clients. Your goal must be to understand your clients’ individual businesses and be able to identify the different solutions for their unique issues.

There are also many other federal and state regulations outside of tax and accounting that you’ll need to stay current on if you want to be a VIP to your clients. For instance, the U.S. Department of Agriculture (USDA) oversees all hemp production. Rules are being written and rewritten regularly, so make sure you are signed up with the USDA to receive email updates. Similarly, the U.S. Food and Drug Administration (FDA) regulates the use of CBD in foods, supplements, and beverages and addresses issues with packaging, labeling, advertising, and claims of medical benefits. Even the U.S. Environmental Protection Agency and Department of Labor are setting new standards and regulations relating to the cannabis industry, which includes hemp and hemp-derived CBD. While these agencies will not be addressing accounting or tax, their decision will impact your clients.

With 46 states, including Illinois, having their own approaches to hemp and hemp-derived CBD regulation, taxation, law, and licensing, as well as county and city ordinances, there’s no way for you to know all the rules everywhere. With that said, I encourage you to at least know your own state’s rules and to keep in mind that hemp and hemp-derived CBD are new and evolving industries for federal, state, and local governments to address. I predict the IRS will audit many hemp and hemp-derived CBD businesses in the years ahead. So, if you dive in and get up to speed on all things hemp, CBD, and cannabis, you stand to be an invaluable advisor to clients, an advisor they can trust to steer them toward success and away from the fates of early cannabis industry CEOs who faced fines and worse for doing things the wrong way.

Leave a comment